How to Apply Risk Assessment to Your Estimate

By evaluating your estimate for potential problems ahead of time and developing strategies to address them, you’ll improve your chances of having a successful project. You've completed your take-off, entered the job quotes, applied profit, overhead, and taxes to your estimate, and you believe you've accounted for everything. What could possibly go wrong? Plenty. The questions you have to ask yourself

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By evaluating your estimate for potential problems ahead of time and developing strategies to address them, you’ll improve your chances of having a successful project.

You've completed your take-off, entered the job quotes, applied profit, overhead, and taxes to your estimate, and you believe you've accounted for everything. What could possibly go wrong? Plenty. The questions you have to ask yourself are, Where will the project go awry, and what can you do as the estimator to reduce the possibility of the project coming in at a loss? Risk assessment estimating is the best weapon you have against project catastrophes, as long as you follow these steps:

Analyze the project.

Determine if it's advisable to undertake the project.

Identify, quantify, and monitor your risks.

Analyze the project.

First, study the plans and specifications of the project as a whole. This allows you to determine whether or not it fits in with your company's mix of projects. You should take into account the following factors:

Determine the advisability of the project.

As you evaluate the project, it's possible to forget the most important question: Should you undertake it at all? But answering that question requires you to address other issues first. Will the work disrupt or interfere with other business operations? Is your present organization properly trained and equipped to take on this project? Do you have access to a sufficient number of trained electricians? Is your present stock of tools and equipment adequate for this type of project? Are there other electrical contracting firms available who can more expeditiously handle the work? Once you've convinced yourself it's advisable to tackle this project, you must identify the potential risks you will face in doing so.

Identify your risks.

All of your risks may not be apparent when you first analyze the project, so it's worth your time to review job cost records for similar projects. Familiarize yourself with the problems that plagued earlier projects. For example, if you plan to outsource part of the project or use a specific supplier, talk to project managers who have used these resources in the past. It's also a good practice to attend project management meetings and note field problems for use in future estimates.

There are numerous ways to identify risk. You should review the tasks and history of similar projects. Brainstorm and discuss the project with your estimating team. Consult with project managers within your company that have run similar projects and identify problems they encountered. Most importantly, review the schedule.

During your review, look for areas that could eventually lead to problems. Identify tasks for which your company has no expertise. It's likely you'll underestimate the duration and cost estimates for these tasks. Ask yourself how consistent your estimates have been in the past. Be careful with duration and cost estimates that are aggressive. You should also take note of tasks for which you have limited resources. Take special note of tasks with several predecessors. The more dependencies a task has, the greater the likelihood of a delay. And don't overlook time-consuming tasks that require a lot of resources. The larger the task, the more likely the estimate will be inaccurate.

Quantify your risks.

It's important that you quantify your risks so you'll know how a delay or cost overrun will affect your bottom line. Start by determining your tolerance level. Then assign a probability and cost to each risk. Finish by assigning a priority to each risk.

Set tolerance levels.

If you're a small company, additional project costs or delays may put your entire company at risk. If you're a large company, some overruns and delays may be acceptable. But no matter what size company you have, make sure you write down some hard numbers. How much cost and delay is acceptable? Remember, this isn't your preference, it's just the bottom-line number your company can tolerate. A smaller company may be able to accept a tolerance level equal to profit, whereas a larger company may accept profit plus several thousand dollars.

Assign a probability to each risk.

Use historical job cost data to determine the likelihood of each risk. There are programs designed to compare bidding history against your current estimate. Using one of these programs can help isolate potential problem areas in the estimate. Next, determine the likelihood of your company taking a loss on a given project. For example, if your company historically incurs losses 40% of the time it undergoes a particular task, flag that task as a risk. Based on these numbers, set a percentage level at which a task will be considered risky.

Assign a cost to each risk.

The cost of a risk can be measured in dollars, lost time, lost quality, or a combination of the three. You must realize your biggest risk is associated with labor. As you know, project overruns are covered by profit. To quantify this risk in dollars and cents, divide the projected profit for all of the tasks at risk by the labor dollars for all of those tasks. Subtract the result from one. The result is known as a labor risk factor. Multiply that resultant by the total labor cost to obtain a risk cost:

Risk Cost = [1 - (Total Profit/Total Labor)] x Total Labor

If you don't know the cost of a task or you're estimating a smaller project, use the same process, but insert the total profit and total labor dollars for the project in the formula. Compare this amount with the tolerance level (in dollars) you calculated above. If your risk cost is more than your tolerance level, you'll need to adjust your bottom line or pass on the project. The more profit you've built into the project, the less likely the risk cost will reach your tolerance level.

Let's look at an example. Assume you're estimating a project that includes a power distribution system, fire alarm system, and security system. You've calculated a tolerance level of $5,000. Job cost records reflect you've suffered losses of more than 40% on both the fire alarm and security systems in the past. You estimate profit on the fire alarm system to be $3,400 and labor costs to be $9,200. Your estimated profit for the security system is $2,800 with labor costs of $7,400. Your total profit estimate is $6,200, and your total labor cost is $16,600. Plugging these numbers into the formula yields:

Risk Cost = [1 - ($6,200/$16,600)] x $16,600 = $10,400

As you can see, your risk assessment indicates you've exceeded your tolerance level. Therefore, you must make a choice: Increase your bid by $10,400, or don't submit one.

Assign a priority.

Assign a priority to the risk based on your company's tolerance level, the potential cost of the risk, and the probability of it occurring. If you're awarded the project, make sure you give this list of risks to the project manager — once you've identified and quantified risks, you need to plan for them.

Risk monitoring.

Now that you have this priority list, what is the project manager supposed to do with it? As the project progresses, he or she should review job cost records and note problems at project management meetings. From this feedback, you can develop new estimating procedures to limit potential risks.

With a little preplanning, thought, and communications with project management, you can significantly decrease the risk to your future projects through risk assessment estimating.

Hague is President and CEO of ConEst Software Systems in Londonderry, N.H.

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